11 Smart Year-End Tax Planning Tips for Your 2016 Return

Adjust Your Portfolio

Allowing taxes to dictate your investment strategy is rarely a good idea. But if you’re already considering selling appreciated securities or other assets, cutting them loose by year-end could save you money.

If you’re in the 15% tax bracket, you’ll pay 0% on long-term capital gains. In 2016, you’re eligible for the 0% capital-gains rate if your taxable income is $37,650 or less if you are single, or $75,300 or less if you are married filing jointly.

If you won’t fall into the 10% or 15% tax bracket, perhaps someone in your family will—an adult child, for example, or an elderly parent. Some appreciated stock could a make nice stocking stuffer with tax savings to boot. But it's complicated -- we'll discuss the details on a later slide.

Top Off Your Retirement Savings Plan

• Money contributed to an employer-sponsored retirement plan, such as a traditional 401(k), isn’t included in your taxable income. In 2016, you can contribute up to $18,000 or $24,000 if you’re 50 or older, by the end of the year. If you haven’t maxed out, ask your employer if you can make an additional contribution before December 31.

If you have self-employment income from a side job, you can sock away even more. You can contribute up to 20% of your net self-employment income to a Simplified Employee Pension, up to a total contribution limit of $53,000 for 2016. (Unlike 401(k) contributions, there’s no December 31 deadline for SEP deposits. You can make 2016 deposits anytime before the due date of your tax return.)

Another option: Depending on your income, you can also deduct contributions to an IRA, up to a maximum of $5,500 in 2016 (and $6,500 for workers 50 or older). You can make 2016 IRA contributions anytime before April 17, 2017. Roth IRAs, however, do not offer this upfront tax break because withdrawals are tax-free in retirement.

Convert to a Roth

If your income declined this year—because you retired, for example, or took an unpaid sabbatical—consider whether this is the time to convert some or all of the funds in your traditional IRA to a Roth before year-end. You must pay tax on the amount you convert (except for any after-tax contributions), but if you’re in a lower bracket now than you’re likely to be in later, it can really pay off. Once you convert, future earnings are tax-free, as long as you’re at least 59½ and have owned the Roth for at least five years when you withdraw the money. To get the maximum amount of tax-free growth, use money from outside your IRA to pay the tax bill.

Give to Charity

This is a great time of year to clean out your closets and garage, but you can write off donations to a charitable organization only if you itemize deductions. A few bags full of gently used clothes and household items can add up to hundreds of dollars in tax deductions, but valuing those donations can be difficult. (Try Turbo Tax's free tool.)

If you donate a used car worth more than $500 to charity, your deduction will be limited to the amount the organization receives when it sells it. But you may be able to claim a bigger deduction based on the vehicle's fair-market value if the charity uses it to deliver meals, for example, or gives it to a needy individual. The charity will list the vehicle's sale price, or whether an exception allowing a higher deduction applies, on Form 1098-C, which you must attach to your tax return. Because of previous abuses, donations of used cars and other noncash items may attract extra scrutiny from the IRS. So keep scrupulous records.

Send cash donations to your favorite charity by December 31 and hang on to your canceled check or credit card receipt as proof of your donation. If you contribute $250 or more, you'll also need an acknowledgment from the charity.

Give Really Big to Charity

If you plan to make a significant gift to charity this year, consider giving appreciated stocks or mutual fund shares that you've owned for more than one year. Doing so boosts the savings on your tax return. Your charitable-contribution deduction is the fair-market value of the securities on the date of the gift, not the amount you paid for the asset, and you never have to pay tax on the profit.If your favorite cause can't accept donations of appreciated securities, consider opening a donor-advised fund instead. The fund administrator will sell the securities for you and add the proceeds to your account. You can deduct the value of the securities on your 2016 tax return and decide later where you want to donate the money.

And, for the first time in years, retirees won’t have to wait for Congress to renew a valuable tax break for charitably inclined IRA owners. Last December, Congress made permanent a law that allows seniors age 70½ and older to donate up to $100,000 from their IRAs directly to charity. The contribution counts toward your required minimum distribution and isn’t included in your adjusted gross income. That could qualify you for tax breaks tied to your AGI and reduce or eliminate taxes on your Social Security benefits.

Give to Your Family (or Other Lucky People)

You can give up to $14,000 to as many individuals as you like before Dec. 31 without filing a gift-tax return. If you’re married, you and your spouse can give up to $28,000 per recipient.

The case for using the annual gift-tax exclusion for transferring wealth to adult children (or other lucky recipients) isn't as strong this year as it has been in the past. The estate-tax exemption, which is indexed to inflation, is now $5.45 million. Only a handful of ultra-wealthy families need to worry about the estate tax at that level. But 11 states and Washington, D.C., have lower estate-tax thresholds than the federal government. New Jersey, for example, taxes estates valued at as little as $675,000.

If you're feeling really generous, you could do it all over again on January 1, 2017, when you can give up to $14,000 per person.

Give the Gift of Securities

If your adult children or parents are in the 10% or 15% tax bracket (taxable income of $37,650 or less for singles, or $75,300 for marrieds), they qualify for the 0% tax rate on long-term capital gains. When they sell the securities, profit that would have been taxed at a rate as high as 23.8% on your return will be tax-free on theirs. Children under 18 and full-time students under age 24 are subject to the “kiddie” tax. Investment income that exceeds $2,000 will be taxed at the parent’s higher rate.

To qualify for the special rate for capital gains, the securities must have been held for at least 12 months. For securities given as gifts, though, the holding period includes the time you owned them.

This strategy requires finesse. When you sell stocks or funds, your gains lift your taxable income. Sell too much and you could push yourself out of the 15% tax bracket, which means you’ll end up paying taxes on some of your profits. To avoid taxes entirely, you’ll need to calculate the amount of gains you can reap before your income exceeds the threshold. Note also that your state may tax long-term gains that go tax-free at the federal level.

Penalty-Proof Your Return

If you expect that you'll owe money when you file your 2016 tax return next spring, you can avoid an underpayment penalty by boosting your withholding now. Hustle over to whoever handles your payroll to adjust this.

You needn't pay every penny of the tax you expect to owe. As long as you prepay 90% of this year's tax bill, you're off the hook for the penalty. Or you can escape its reach, in most cases, by prepaying 100% of last year's tax liability. However, note that if your 2015 adjusted gross income topped $150,000, you'll have to prepay 110% of last year's tax liability to avoid a penalty.

Taking these steps to boost your withholding at year-end will shield you from an underpayment penalty on your 2016 return, no matter how much you actually owe when you file your return.

If you have both wage and consulting income and expect to owe money on your tax return, you'll do better by boosting the taxes withheld from your last few paychecks rather than trying to make up the shortfall with your final estimated quarterly payment, due January 15, 2017.

Taxes that are withheld are treated as if they were spread out evenly throughout the year, so that approach sidesteps an underpayment penalty; the estimated-tax-payment approach does not.

Fiddle with Your Income Payments

If you think a year-end bonus is in the works, ask that it be paid next year. That way, it won’t increase your 2016 taxable income. (If the firm has already announced that it will pay bonuses in December, though, it’s 2016 income even if you don’t cash the check until January.)

If you’re self-employed, send bills to clients in late December so you won’t receive payments until after the first of the year. And if you get income from a closely held firm, consider delaying that dividend.

Hurry Up that Procedure?

In 2016, most taxpayers can only deduct unreimbursed medical expenses that exceed 10% of their adjusted gross income. (If you or your spouse are 65 or older, you can deduct medical expenses that exceed 7.5% of AGI.) That high hurdle prevents most taxpayers from writing off medical costs. If you’re close, though, consider scheduling medical or dental work before the end of the year to clear the 10% bar and take advantage of this tax break on your 2016 tax return. Deductible expenses include everything from laser eye surgery to a portion of your long-term-care insurance premiums.

Another consideration: Tax reform plans under consideration aim to lower rates and simultaneously reduce deductions and credits. The ability to deduct medical expenses could go away altogether. Something to consider—but don't rush your surgeon unnecessarily.

Get that (Underwater) House Sold

If you’re negotiating with your mortgage lender to sell your home for less than you owe on the mortgage, be sure to get the contract signed before December 31. Ordinarily, forgiven debt is taxable, but Congress extended through the end of this year a provision that excludes from taxes up to $2 million in forgiven mortgage debt on a principal residence. The exclusion will apply to mortgage debt forgiven in 2017 if the agreement to discharge the debt is signed in 2016.